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European Competitiveness Pact: A breakthrough or a Red Ocean doom?

The European Competitiveness Pact is the latest proposal raising havoc among European Union members. Spearheaded by Germany and France it has been portrayed as a remedy to problems behind EU periphery’s debt crisis but also as precondition to much needed easing of their bailout terms in what has been bluntly dubbed as the “Grand Bargain”.

Sounds like euphemism in a way: what should have been an ambitious plan to push forward development and growth across European Union, it is mainly limited to restrictive fiscal policy, let alone promoted as a restrictive, punitive deal that causes public resentment. Furthermore, the introduction of a common policy apart from taking away power from national governments, a sensitive issue, risks creating uniformity across EU member states to the extent that doesn’t exist even in the US. This may increase correlation among European economies and take away a useful internal decoupling mechanism.

A. Decoding the ‘Great Bargain”

According to the original document circulated (and its unofficial translation), the Competitiveness Pact aims at achieving:
1 price competitiveness (eg, stability of real labor cost, realigning labor cost according to development of productivity);
2. Stability of public finance (explicit and implicit public debt);
3. Minimum rate for investments in research, development, education and infrastructure of x% of gross domestic product (value to be decided).

Going deeper into specific measures, the Pact proposes:
1. Abolition of wage/salary indexation systems;
2. Mutually recognize education diplomas and vocational qualifications for the promotion of mobility of workers in Europe;
3. Create a common basis for corporate income tax;
4. Connect pension system to demographic developments (ie, average age of retirement);
5. Oblige member states to commit to tight debt control through clauses in their constitutions;
6. Establish a national crisis management regime for banks.

Much can be said about each one of these metrics, the culprits targeted and their potential effectiveness. The common corporate tax basis for example is directed to Ireland’s low corporate tax rate (Irish claim is key to their growth), wage indexation is practiced in Portugal, Belgium, Greece as is lose fiscal policy and high indebtedness (but then again not only by them).

Trying to decode motivations behind the Pact one can appreciate Germany’s concern over allowing certain economies to roll back into the same crisis and require further bailouts in the future (much discussion has been done on moral hazard these days). On the other hand one should also be critical of these measures’ results and effectiveness.

In this posting we’ll focus on wage levels; after all deficits, public debt, social security and taxes are all related and have reached their limitations in several countries. Analyzing the labor cost we will address certain misconceptions and through that show why this Pact might be missing the mark in raising competitiveness where needed.

B. Labor Cost and Productivity across Europe: Myths and Reality

Comparing labor costs across Europe and other developed countries it’s clear that wages in the European South are much lower, both on gross and net basis.

Another interesting finding is that divergence between the Northern and Southern Europe figures is much higher on gross salary basis than on GDP per capita or net salary figures. This could be due to higher salary deductions in Northern Europe as well as higher levels of self-employment or unreported economic activity in the South. Even in the case of potential tax and social security contribution evasion the solution can’t only be lowering labor cost but rather taking corrective actions where needed, to boost state income and reduce liabilities over a period of time.

Wage level is not the main parameter affecting competitiveness; equally important is what’s produced with this labor cost. Looking at labor productivity across Europe, US and Asia we can see that Southern Europeans are working more hours than their Northern counterparts; contrary to stereotypes and prejudices repeated on various occasions. At the same time however they produce much less of what produced in Northern Europe in terms of output value (GDP per hour worked). Productivity is probably even lower from official figures if illegal labor is taken into the equation.

Low productivity can be attributed to inefficient production methods, low value added products, as well as restrictive legislation and other structural problems. Looking at the Greek economy for example, it is being characterized by services while Germany’s by high value added/export oriented technology sector. Greece is also suffering by a non-conducive to businesses legal framework and economic environment, as international rankings show. What’s the reason for that is a separate discussion, but it’s not a labor cost problem.

A straightforward expression of lower competitiveness can be found in the South’s much lower R&D expenditure. Undoubtedly these are economies that are coming from different starting points and move with different speeds. In the absence of no intervention these differences will persist in the future.

To be fair, the European Union has been trying for years to promote economic development across its members. The 2000 “Lisbon Strategy for Growth and Jobs” called for increase in innovation and employment over a ten year period. A minimum 3% R&D expense target across all Europe was set then which was not finally attained even by highly developed economies. The program also didn’t reach its employment targets. Some reasons for that was the difficulty in steering centrally planned policies through national governments and politicians that may have different priorities or capabilities.

Maybe the reason of this failure lies in the root of the European economic system that favors public investment and crowds out private investment discouraging this way productivity gains; the usual objection to Keynesian policies.

This phenomenon can be more evident in countries that are trying to catch up and usually lack a robust private sector: investment might end up in public projects of questionable utility that although may help in increasing wages and GDP, they don’t contribute in raising competitiveness and promoting long term sustainable development and growth.

In any case R&D investment, on its own, is not a panacea. To be effective it requires the existence of research infrastructure, know-how and a sizeable pool of R&D personnel, otherwise it will be money thrown out of the window raising more excuses against good intentions. Moreover it requires the existence of a business environment that will nurture innovation which cannot happen in economies that lack respective infrastructures. Researchers cannot produce in vacuum; students won’t be inspired without real life stimulus, role models and most importantly opportunities to work and grow professionally. Automobile research for example makes sense when carried out close to an established production base where scientists can have immediate access to automobile production, testing facilities and specialists to exchange views on a frequent basis. Marshal plan worked where there was an infrastructure to leverage; on the other hand, much higher foreign aid has failed elsewhere. Apart from technical infrastructure the financing capability should be there as well: next to Silicon Valley’s vibrant startup community stands a robust venture capital sector capable to lend a helping hand.

Finally, under current dire fiscal conditions in Europe’s debt-ridden periphery it is probably difficult to allocate 3% of GDP to R&D. Even if this is possible, R&D as a percentage of GDP might result in a meaningless number in absolute terms once applied over an already low GDP number. Three percent of a low GDP economy, might not yield the same results as three percent of a much larger GDP economy. It might simply not be sufficient for meaningful research to be carried out these days, especially when a low productivity country is struggling to catch up. For example it may be required to pay comparatively higher salaries to attract researchers to relocate there. Mutual recognition of diplomas that is proposed under the Pact can increase mobility but the real factor for that is employment opportunities; human capital will flow to where opportunity lies, causing underdeveloped regions a “brain drain”).

C. Management Perspective: Competitiveness Pact as a Red Ocean Doom

Going back to the Pact: what is then trying to achieve when it comes to labor cost?

In a typical European state run economy the public sector sets the stage for salary levels; these salaries may be even higher than those in the private sector due to collective bargaining or other inefficiencies. The consequence is that there’s limited propensity for people to “go the extra mile” once there’s secured and descent income in the public sector. That results in an inefficient, marginal private sector that is unable to compete internationally and lead countries out of the crisis. Since the corporate sector is not competent enough to productively invest in R&D; the government should again step in to support such efforts; a vicious cycle.

By lowering salary levels we are simply continuing to produce the same albeit at lower cost. Sounds like a typical Porter’s Cost Leadership strategy for those familiar with management literature; or referring to a newer terminology a “Red Ocean” doom. When applying this strategy the objective is to outperform the rivals in capturing a larger share of an existing market; in which case competition turns bloody.

That brings to mind a movie quote; it always does. As a manager that I respect used to say: movies have in them anything you need to know. Even if not, still a quote helps in making a point. So here’s what “Larry the Liquidator” from the “Other People’s Money” movie said at a proxy fight over an underperforming company:
And you know the surest way to go broke? Keep getting an increasing share of a shrinking market. Down the tubes. Slow but sure.
You know, at one time there must’ve been dozens of companies makin’ buggy whips. And I’ll bet the last company around was the one that made the best goddamn buggy whip you ever saw. Now how would you have liked to have been a stockholder in that company?

Then you might wonder what market is European periphery competing in? Without getting into detail, economies are not that extrovert, they are more into services. In whatever they produce there are other countries that have far lower cost structures and will continue to do so for the foreseeable future. In the absence of higher value added output the proposed Competitiveness Pact seems like an attempt to perpetrate the same model in the South albeit at lower cost; a losing strategy not to mention the social and wider economy consequences of that. Even China has recently outlined plans to move from low cost production to high technology and new energy. US has made that shift long time ago with clear indications that the workforce should be retooled and education geared towards science and technology.

So is this Competitiveness Pact simply a damage control exercise? ie solidifying a Euro nanny-state where the periphery will be at perpetual life support/lower gear compared to developed EU states?

There can be another explanation right out of the Austrian School of Economics though: by lowering wages and increase unemployment through structural reforms a creative disruption might be created that will force unleash the economy’s potential to grow out of the crisis. Based on the above, this sounds like a risky strategy if not wishful thinking. Societies can’t jump start or adjust to new circumstances quickly; it would have been nice but can’t redeploy the workforce in new sectors. As the saying goes: “can’t teach an old dog new tricks”. Have to invest in education and transition over time to avoid social crises.

D. So where’s the solution? The Blue Ocean?

There are various ways to represent risk created by debt. Leverage can be quantified by the ratio of debt to GDP or debt to national wealth (problem is that the latter is difficult to measure). On the other hand the risk of debt servicing (liquidity risk) can be represented by the interest expense to total income. A country might be highly leveraged but at the same time might have significant property or ability to increase income (increasing taxes or curbing tax evasion being one).

The most commonly used leverage ratio of debt to GDP (solvency ratio), can be reduced by reducing the nominator (debt) or increasing the denominator (GDP). Ruling out bankruptcy as a solution, which wouldn’t benefit anybody (bondholders, Eurozone countries or global markets, even recently US expressed their concern over that), public debt can be reduced over time by cutting down deficits, restructuring the debt to lower interest expense or buying back some or spin it off through privatizations. Austerity can have its limitations though: after two years of austerity that caused the economy to contract, Ireland saw its deficit to increase and is realizing its bailout program might be unworkable. It now aims to renegotiate terms. Same might happen elsewhere.

Leverage can on the other hand be reduced by increasing GDP. Growth is of paramount importance not only to decrease that risk but also to ensure long term prosperity and competitiveness in today’s globalized economy. In other words, instead of a Cost Leadership strategy that would aim to reduce debt (ie the ratio’s denominator) the solution could be growing out of the crisis (increasing GDP, the nominator) by diversifying into new markets and high value added products. These new opportunities are called Blue Oceans under the respective strategy model.

To enable such transformation it would first be useful to remedy structural problems to provide the necessary breathing room for the private sector to flourish. Then the question would come to which industries to invest in? Looking at R&D expenditure around the world it seems that EU is investing proportionately more on pharmaceuticals, automobiles, aerospace, chemicals and communications. This is not coincidental; there are many dominant companies in these sectors, mainly in Northern Europe. On the other hand the US invests proportionately more on technology and software.

Europe’s periphery, apart from Spain, lacks to a large extent heavy industry. Therefore it would be wise to invest in less capital intensive industries such as software or niche technologies, even services (why not some outsourcing as well; there can be opportunities in certain niches). Ireland is following this path. Green technology is another sector that can be developed which brings the additional benefit of reducing imports.

Finally, going back to the decoupling argument, this investment could also have a positive effect elsewhere: considering the high growth and overheating of the German economy it could be possible to transfer certain production and research to the South and provide employment opportunities for scientists and professionals there.

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Moody’s downgrades Greek debt; says it’s speculative.. Really?

Moody’s today downgraded Greece’s debt by three notches down to Ba1, lower than Egypt’s. Pretty much beating a dead horse. Greece is mostly out of debt markets and will remain like that for a year or so until internal structural reforms take shape. EU periphery’s debt has thus become a mostly internal EU issue. Political rhetoric apart, EU is probably holding a tough stance to keep pressure on reforms. Greece for example has introduced all requested reforms but now has to leave time to sit in; while also increase tax revenues at least from unreported activity (Greece has high self employment rates and that’s not straightforward to tax).

EFSF’s chief Regling recently stated that Greece’s plan implementation is going well and that Portugal and Spain seem safe for now. Same point made by IMF’s European chief Antonio Borges on the back of Moody’s downgrade. There’s certainly room to maneuver when it comes to fiscal policy within the periphery, as well as ability to support from EU’s core. A default wouldn’t benefit anyone since European banks hold much of periphery’s debt. If EU wants to provide support through the EFSF or ECB, it certainly can. So this downgrade or subsequent market speculation might not make a difference. Internal reforms are policy measures that with solvency risk out of the picture, their resolution is going to drag for some time. Seems like a long trade for shorts; do they have the time for that? On the other hand seems that shorts have moved to the US$ in light of ECB’s interest rate hike.

There can be an alternative reading to this downgrade though (which by the way happened just days before EU’s leadership meeting and the day before Greece was supposed to tap into markets for a 6month T-bill issue). Could this just be another act in the clash between the EU and rating agencies? EU is skeptical of their ratings and have placed them under supervision (from the European Securities and Markets Authority) so this might be some power struggle play unfolding. Credit ratings seem to place themselves on the buyers’ side; is this some market strategy shift at least on the sovereign debt sector? Due to this timing it will also be interesting to see whether ECB will step in support Greece’s issue as probably did with Portugal.

And by the way, was anybody waiting for Moody’s to call Greece’s debt speculative just now? Following the crisis, rating agencies are under fire on all fronts. It’s only opinions they say they are expressing. Thank you, we have ours too (and as history showed any sophisticated investor should better have their own going forward too).

PS. Stay tuned for additional commentary on why fiscal policy on its own is not sufficient to take Europe’s periphery out of the crisis and why growth policies are urgently needed.

Related links:
http://www.reuters.com/article/2011/03/07/us-eurozone-idUSTRE72345N20110307
http://www.reuters.com/article/2011/03/07/us-imf-greece-borges-idUSTRE72642V20110307
http://news.yahoo.com/s/nm/20110305/bs_nm/us_eu_regling
http://blogs.wsj.com/source/tag/european-securities-and-markets-authority/#
http://in.reuters.com/article/2011/02/24/usa-ratings-sandp-idINN2427345520110224

The European debt crisis as a foreign exchange control mechanism!

What has long been discussed as a rather cynical point of view among many, it was recently openly admitted by Germany’s Finance minister Wolfgang Schaeuble at an interview to the Focus magazine. There Mr Schaeuble mentioned that Greece’s exit from the Euro would lead to Euro appreciation and eventually hurt German exports. Despite of public and political concerns in Northern Europe, Euro’s relative weakness benefits Germany’s exports and strong rebound. At the same time healthy European economies can take their dividend from lending to the periphery for a markup through the EFSF/ESM facilities.

Mr Schaeuble is among the European politicians with the more sound positions regarding the European currency and governance, expressed throughout the crisis. He underlined long ago the need for a common fiscal policy to support the Euro, something which is challenging under EU members’ current governance regimes. It is long overdue though and would have averted excesses in certain countries should it have been in place or if effective supervision was exercised by EU mechanisms. Maybe a crisis was needed to bring about this change. Now a much needed support to debt ridden countries through debt buyback and rescheduling using the EFSF or ESM facilities could only be given the go-ahead pending acceptance of the proposed European Competitiveness Pact; what has bluntly been called by EU officers the “Great Bargain”.

We will revisit the European Competitiveness Pact as more information become available. At this point it seems however that fiscal measures included there cannot alone solve EU periphery’s developmental problems. More far reaching structural reforms and investment in innovation is needed for that. Maybe this will be the next centrally designed policy plan to be introduced on the back of a future crisis, once fiscal policy has run its limitations and can’t respond to employment/growth needs.

Or, are we aiming for a Euro nanny-state where the periphery will be in perpetual life support/lower gear compared to developed EU states?

Related articles: http://www.bloomberg.com/news/2011-02-26/greek-euro-exit-not-taboo-but-wrong-schaeuble-tells-focus.html

EFSF and country bailouts: the European TARP or something more?

The EFSF (European Financial Stability Facility) is a special purpose vehicle that was created last year in order to provide support to troubled European economies. EFSF can issue loans backed by EU country guarantees and IMF loans. A maximum of €750 billion can be raised under the current agreement although much less will in order to keep its AAA rating.

EFSF’s creation was shadowed by market turmoil and public unrest. However, half a year later, it starts to show how an important tool can be for the European Union. According to its operating guidelines EFSF can provide loans to eurozone countries, recapitalize banks or buy sovereign debt. In EFSF’s first band issue as part of the EU/IMF financial support package agreed for Ireland €5 billion were raised at 2.89% which will be loaned out to 5.8%. Not that bad deal after all for the Eurozone. And in the meantime the whole crisis devalues the Euro much to the benefit of the export-driven European nations. No much doubt that the facility can be increased if need to take more economies under its wings. Although this European “bailouts” seem to face some political headwinds they make economic sense. On the other hand isn’t the EFSF effectively becoming the financing arm in the course of shaping a rather “invisible” common European economic policy? Countries that request support have to align their policies under IMF/EFSF guidance; the ones coming under the EFSF being probably are the ones that have lost their credibility. To take it a step further, isn’t the latest bond issue a type of Eurobond that so much discussion have been made about lately? Eurobonds may be some years away; in the meantime Germany and other healthy economies are keeping their financing ability and rating intact.

But let’s go back to the economic consequences from EFSF’s actions. In the European setting, buying back government debt, the “toxic assets” behind the European crisis, pretty much means recapitalizing the banks. European banks hold much of the European debt; they mostly had to, under the European economic model. That’s the case with the Greek debt held by large European banks and all of Greek banks. Restructuring Greek debt to 50% of face value, as current market valuations imply, would decimate the Greek banking system requiring massive recapitalization for its size to satisfy capital adequacy guidelines. One objection here would be that Greek banks hold most of the debt in their investment portfolios i.e. at book values so they might seem indifferent towards a buyback in the wake of having to take losses. Even so though, the main problem is that their market capitalization has evaporated during the crisis as well as their funding capability. In this way the EFSS buyback can free up capital to finance economic growth and push back the “toxic asset” issue: effectively growing Europe’s way out of the crisis. Isn’t this what TARP meant to do?

I guess the main issue would be the timing of such buyback and be the haircut. Probably this couldn’t happen earlier than market reforms have been implemented. In the case of Greece this will happen after the first half of 2011. As regards to the haircut, certainly this should be lower than the 50% markets imply for Greece. Probably, somewhere in the 25% range, considering recent rumors and the target effective government borrowing after refinancing at lower rates (discussions are for 25% discount on 15-20% of debt outstanding). Some might say that this would still maintain a high, not manageable, debt level for Greece. However should it starts growing again with a sound plan, which should be the main concern., and manage to get its finances in order by reducing useless, unproductive spending and get tax income finally flowing in, then, it will be able to serve interest payments. For those in doubt mind that this time the whole process is administered by the IMF/EU. As regards to the debt/GDP ratio this is only an indicator; it’s probably more useful to focus on the interest/GDP indicators. Furthermore one has to consider the country’s true wealth, what that actually should be for Greece considering its stealth economy? In the end Greece was surviving with 100% debt/GDP for years as did Italy or Belgium without raising concerns.

On the other hand: maxing up your credit card makes you more conservative as a buyer or at least limits your options….. So not bad as a self-restraining measure. This will be a good lesson; but will need some time to sit in with the people.

After all: Every cloud has a silver lining or from another view “You never want a serious crisis to go to waste”. I see the European stockmarkets, especially those of the PIGS to move lately. Would they know something?

The US recovery, the European debt Crisis and Gordon Gekko; still to the point

Ok, this post has a light tone; as much as one can observe the economy this way.

First about the European debt crisis: Portugal and Spain are coming into the spotlight. Most probably will be the next ones to seek IMF/EFSF support. That’s if the ECB or somebody else comes to aid. They will do so if there’s significant confidence over their policies; the jury is still out on that. That apart, everything looks like the Greek story all over again; one year later. The only difference is that while Portugal’s and Greece’s problems have the same culprit in their public sector, Spain’s problems come from the banking sector. If the same story is repeated, it should go like this: once government liquidity dries out the macro funds will attack driving up spreads. Why? Just think of Bud Fox asking Gordon Gekko why he had to break apart his father’s company:

Bud Fox: Why do you need to wreck this company?
Gordon Gekko: Because it’s WRECKABLE, all right?

Simple. Hopefully something good will come out of all this in a more coordinated EU economic policy.

Now coming to the US recovery: after all the drama about the double dip recession the economy seems to recover. Unemployment and real estate prices apart, the stockmarket and corporate profits are doing well, very well indeed. We are at the point that companies disappoint even when they hit the higher profitability in a decade as was the case with Ford recently. “Buy the rumors and sell the news” at its best. It seems that the FED has averted a prolonged crisis. However, I don’t think that quantitative easing will help reduce unemployment, at least not directly, as it used to happen in the past when lower rates could spur labor intensive investment. Times have changed and in a global economy unemployment is more of a structural problem that has to be dealt from market participants (in the absence of government interference). On the positive side though, I believe that FED’s strategy is rather forcing investors to flee risk free assets and invest in equities in order to counter future inflationary pressures. This will improve consumer feeling because of their inflated nests and also remedy the banking sector’s maladies by inflating real estate prices to catch up with historical costs.

Going back to the crisis though, what would Gordon say about where we are standing now?

Bud Fox: How much is enough?
Gordon Gekko: It’s not a question of enough, pal. It’s a zero sum game, somebody wins, somebody loses. Money itself isn’t lost or made, it’s simply transferred from one perception to another.

In other words: money was not lost; just transferred. Now has to go back to work. Won’t be surprised to see the Dow hit 2007-2008 levels by the end of the year. Sad to see the unemployment persist though and not being tackled. It seems as a social issue rather an economic one anymore.

P.S. Talking about Gordon Gekko my thoughts and wishes go to Michael Douglas. Wish him well. Great actor.

US December jobs report: lower than expectations, yet again good news; turning point with a twist..

The US private sector added 113,000 jobs in December according to the Department of Labor; 297,000 according to ADP.  Seasonality might be the reason for the disparity; I believe that the two numbers will converge as seasonal adjustments kick in during the next months.  The focal point should be that unemployment decreased to 9.4%, the lowest since May 2009 (which I believe was the point in time that US economy adjusted to the post-crisis level of economic activity).  Therefore, at this point the economy has to deal with structural unemployment created from jobs lost in specific sectors over the years that found a way to materialize during the crisis.  Unfortunately most of these are not coming back, and unfortunately the long term unemployed are not going to get back to work easily.  So it’s not myopic to focus on the unemployment rate.  Since employers won’t hire somebody who is long term unemployed or in a diminished job sector, that means that for the ones with a job things are getting better.  This will lead to salary and price inflation and progressively erase negative mortgage values and low real estate prices (all right I’m not forgetting lower consumption and consumer credit due to unemployment but even if some people get back to work the benefit would be marginal considering their probably reduced wages or low spending).  At the same time long term unemployed will have to be supported by the state increasing federal spending and deficits, hence more inflation.  Well, this is not going to be good news for the high net worth individuals but one can’t have it all.  Probably this is the milder way out of the crisis; without seemingly taking tough decisions.  One however can’t help but ponder over the long term unemployment issue.  As the economy seems to be doing pretty well without them as indicated by corporate profits and the stockmarket; this probably turns to be more of a social issue.  Europe is able to function pretty well with 10% or even higher levels of employment.  However Europe operates under a much different social and economic model that allows this type of phenomena.  Also wanted to note the fallacy of trying to address current economic problems with recipes of the past when markets were not globalized.  Right now lower interest or tax rates won’t necessarily lead to investment in the US because for a global firm it might be advantageous to do so somewhere else.  The jury is still out on how economies will adjust over these circumstances but for the time being let’s stay with the positive note on the latest jobs report.

The Euro, the Greek debt crisis and exaggerations

So much for the Euro and Greek crisis… It looked like the issue was exaggerated and here’s some news about a hedge fund dinner where the idea of shorting the Euro came up: http://www.reuters.com/article/idCNN2515219020100226).  It’s not that there’s no need for serious restructuring in the EU mechanisms, in the economy of Greece and of the other PIIGS but for sure problems were exaggerated as always when there’s unwillingness or inability to counter worrisome voices and room to profit for that. 

It now looks like the Greek crisis is settling with the additional fiscal measures and EU’s backing, while the Euro has come to a more favorable rate for export countries.  In any case this trade is over and we’re now looking at some reversal, at least in the short term.  After all who remembers of the Brazilian crisis 10 years ago?  Brazil is now one of the most promising emerging markets. No that it bears similarities to Greece but the point is that investor sentiment and circumstances change over time. 

The attention may now move to other countries and there’re many countries that may fail their fiscal targets over the next year. One should however look for the ones that cannot raise funds if want to place a bet or hedge (that’s the difference between Greece and the other countries that was compared to over the last months with such comparisons often being unfortunate to say the least).  On the other hand hedge funds may now switch their focus in going long on the global recovery or the next market breakthrough (could this be renewables or emerging markets?) as new capital will be committed in capital markets.

G20 meetings and the Economic Crisis– Differences and Action Plan

The G-20 leaders met in London in April 2009 and the summit covered the status of the financial crisis, world economy, and future measures to be implemented by G-20 members. It presented differing points of view and approaches in Europe, U.S. and Asia.  During the meeting US sough stimulus spending and Europe more regulations.  Emerging markets pressed for more power sharing, more direct investment and less protectionism.  Among the summit’s decisions were the additional funding to the IMF that may fuel growth, more regulation expected with the establishment of the Financial Stability Board (FSB) as well as a commitment to pursue resolutions and breakthroughs in the areas of international trade (Doha round) and green investing.  You may read the official statement at:  http://www.londonsummit.gov.uk/en/media-centre/latest-news/?view=News&id=15892812

In attempting to explain opposition to further stimulus spending, that was more strongly expressed by Germany, some observers claim that the debate fails to take into account differences between the U.S. and European economies such as Europe’s generous welfare states, that mitigate effects to society and economy in recessions as well as its defined benefit pensions plans.  On the other hand the US Treasury Secretary Geithner urged that there’s a need for the rest of the world, to stimulate demand at home “We must set ourselves on a path so that one country, or group of countries, does not consume in excess while another set of countries produces in excess,…”, “American people and investors (around the world) need to understand that we will have the will and the commitment as a country to go back to point that we are living within our means,..”  German Finance Minister Peer Steinbruck said however later this year that Germany has to strengthen internal demand to reduce dependence on foreign trade.

Apart from differences in social systems and structure of the economy one has also to take into consideration circumstances in the respective banking sectors as well as the relative size of spending to the GDP.  Since the beginning of the crisis governments around the world have committed a total of more than $2.6 trillion to bail out banks and jump-start growth. In addition, they have promised to guarantee $2.7 trillion-plus in loans.  That accounts for 21% of GDP for the UK, 16% for China, 7% for Germany, 6% for the US and 2% for France, according to FT data.  These figures have alerted investors that raised concerns over inflation and the value of US$ denominated investments and country ratings elsewhere.

Stimulus and Bailout Plans to Country GDP

Stimulus and Bailout Plans to Country GDP

Source: Germany Says Its Spending Package Is Already Big Enough  Wall Street Journal, March 12, 2009 and data compilation from “Adding Up the Global Bailout”, Business Week, 1-Dec-08

The IMF says that as much as two thirds of the $4 trillion in bank write-downs are yet to be revealed. U.S. property prices are a long way off a strong recovery, which will go on undermining mortgage-backed securities. On the positive site though confidence and appetite for risk has returned to investors as exhibited from the rebound in stock markets.  The following months will certainly be interesting with the debate shifting to the length and pace or recovery. 

A very interesting discussion on the G20 was held at NYSSA with the participation of dignitaries from Germany, India, Czech Republic and US scholars in April 2009, coorganized by the EU-USA NGO www.euusa.org

Related Articles: The G20 Wishlist“, FT March 11 2009,  Industrial Nations Celebrate-Trillion Dollar Compromise, Spiegel April 03 2009, Geithner urges global effort to tamp crisis Reuters, Apr 22, 2009Secretary Timothy F. Geithner, Remarks before The Economic Club of Washington US Department of Treasury April 22, 2009,  Czech PM attacks Obama spending BBC Wednesday, 25 March 2009, FACTBOX – EU leaders’ messages to G20 summit on April 2- Reuters, March 20, 2009, Germany Says Its Spending Package Is Already Big Enough  Wall Street Journal, March 12, 2009, China’s Stimulus Package Boosts Economy, Business Week, April 22, 2009, Asia urged to rethink growth policies amid crisis. Associated Press Stephen Wright, AP Business Writer May 3, 2009, Adding Up the Global Bailout, Business Week, 1-Dec-08, Credit Crisis: Over at Last? Business Week, June 4, 2009, Germany must expand domestic demand, Steinbruck says, BBC 25 June 2009

Turmoil on the FX markets and power struggles: Foreign demand for US financial assets falls, BRICs meet in Russia

This story follows up on discussions regarding reserve currencies and the threat to the US dollar’s role.  It seems that Japan and China have trimmed holdings of US assets.  The US dollar has been losing ground to the Yen but analysts believe that this will hurt the Japanese economy.  At the same China has also been critical of the US dollar role.  Discussions with Brazil over a new reserve currency were initiated.  One has to however put these moves into perspective; US financial market remains one with the highest liquidity and US market one of the largests and that will be for some time.  According to top FX analyst Boris Schlossberg the discussion is more about expressing concerns over US’s fiscal policy and not so much about changing reserve currency policies in China.  After all China holds 10% of US publicly held debt; a massive investment.  However there’s a discussion that has started on this.  Lately the emerging economies have met in Russia; the so-called BRIC bloc. Although there’s not doubt that their share to global economy is increasing is not yet up to EU/US/Japan level. Furthermore they have much different economies; hence probably different objectives. 

 Related Articles:  Foreign demand for US financial assets falls, AP, June 15, 2009, Emerging Economies Meet in Russia, New York Times, June 16, 2009,  Analysis: BRIC’s differences might outweigh common goals, RGE Monitor,16 June, 2009

Europe’s consumer spending, GDP, exports post record drops / Ripple Effects from the crisis across Europe

In a series of statistical shocks that raise doubts about Europe’s economic recovery, the region’s consumer spending, GDP and exports all dropped in the first quarter at an alarming rate, according to EU’s statistics office (Eurostat).  GDP fell by 2.5% in the euro zone and by 2.4% in total EU during the first quarter of 2009, compared with the previous quarter. In the fourth quarter of 2008, growth rates were -1.8% in eurozone and -1.7% in all EU.  During the first quarter of 2009, household final consumption expenditure declined by 0.5% in eurozone and by 1.0% in all EU (after falling by -0.4% and -0.6% respectively in the previous quarter).  Overall these figures paint a grim economic picture. Earlier this year Jean-Claude Juncker, the Eurogroup Chief, has warned that job losses will escalate this year despite measures taken by EU leaders in recent months to boost the economy.  Euro-area unemployment is at a 10-year high of 9.2%, according to the latest official figures.

The crisis has severely affected Central European countries a region that has been experiencing a fast paced growth.  One shouldn’t however look the region as a whole as there are differences between countries and every country is faring differently through the crisis.  IMF and the EU have come to support Hungary that was facing problems in late 2008.  Elsewhere Standard & Poor’s downgraded the long-term rating of Ireland, Spain and Greece expressing concerns over the state of their economies and the financial sector.  Prior to the current downturn, the Irish economy had not experienced a recession since 1983 and enjoyed double-digit growth in the 1990s. In another development that shocked markets, the UK Treasury failed in March 2009 to sell all its government bonds in an auction, for the first time since 2002.

Related articles:  Eurostat portal, Eurostat NewsRelease, 3 June 2009, European Spending, Exports Decline Most in 14 Years Bloomberg Update, Eurogroup chief predicts huge layoffs, euobserver 16.04.2009 , IMF, EU agree Hungary rescue-but will it work? Reuters Oct 29, 2008, Greece’s Sovereign Credit Rating Cut to A- by S&P, Bloomberg  Jan. 14, 2009, Spain Downgraded by S&P as Slump Swells Budget Gap, Bloomberg Jan. 19, 2009, Ireland credit rating cut for the second time Times OnLine June 8, 2009, UK government bond auction fails, BBC, 25 March 2009, Record unemployment in eurozone crushes hopes of fast recovery, Forbes/Reuters (15 June, 2009)